Volatility in the stock markets increases uncertainty. As an investor, it becomes impossible to assess if the markets will crash further or recover. Typically, investors don’t like uncertainty and tend to panic when such situations arise. Also, panic breeds mistakes. And, in a volatile market, mistakes easily translate to losses. Therefore, investors find themselves trapped in a vicious cycle.
Looking at the current market conditions, we thought that it was the right time to talk about ways in which you can break this loop. Today, we will be share five ways in which you can deal with stock market fear effectively. Read On!
There is a famous quote by Warren Buffett: ‘Be fearful when others are greedy and greedy only when others are fearful’. A piece of sound advice, but it lacks detail. Even if you are planning to invest when others are fearful (like during the current market crash), how should you invest in stocks? Many investors make the mistake of making a lumpsum investment assuming that the market has hit rock bottom and will not go down further.
Read more: How to Invest in Share Market
Why is it a mistake?
Let’s look at a real-life example to understand.
This is a chart of the Nifty 50 Index in 2020:
Source: Yahoo Finance
If you look at the 6 yellow lines above, many investors on those days would have considered entering the market assuming that markets had hit rock bottom. Imagine the plight of investors who would have purchased stocks in lumpsum during points 1, 2, 3, 4, or 5. By the time they reached point 6, most of them would have panicked and redeemed to recover as much as they could. Even investors who entered the markets at point 6 cannot be sure that there won’t be a further nosedive.
On the other hand, if an investor invests 10% of his corpus every time he thinks that the markets are down, he takes a lesser risk. Also, since the markets are highly volatile, if he purchases in small tickets every time the markets dip, his average purchase price will drop, increasing his chances of earning gains when the markets recover.
Hence, the first suggestion – avoid making a lumpsum investment.
When markets crash, one of the first reactions is to look for an opportunity to redeem the investments at minimal loss. Let’s say that you invested Rs.1000 in a stock or mutual fund on April 01, 2019. Before the market crash, the value of your investment was Rs.1200. However, as the market started falling due to the pandemic, the value of your investment dropped to Rs.900. If you panic and redeem your investment, then:
The important thing to remember is, if you don’t redeem your investments, then all you have is a notional loss. Since the markets are volatile, they can have some recovery and the value of your investment can rise again. However, if you redeem your investments, then the loss becomes realized loss. Unless you have an emergency for which you need funds, we won’t recommend redeeming investments out of panic.
Most people invest according to their investment goals. The goal can be anything – creating a corpus for your child’s higher education, a nest egg for retirement, etc. It can also be a short-term goal. Based on your goal and risk tolerance, you choose investments. However, when the markets start crashing and volatility and panic sets in, many investors start investing in assets that don’t align with their goals.
Let’s say that you had a short-term goal – an investment horizon of one year. Your investment advisor recommended purchasing debt fund units since they have lower risks with moderate returns. He advises against equity investing since it requires a 5-10-year horizon. After a few months, the markets start crashing due to coronavirus. You find that good stocks are available at very cheap prices and think that it is a good time to buy. So, you redeem your debt fund investment and buy stocks.
This is a mistake.
While making the decision of buying stocks, you forgot that according to your investment goals, you had a horizon of one year. So, you have invested in an asset that doesn’t sync with your goals. Stock markets are unpredictable. If the markets stay volatile for another few months and your time horizon of one year comes to an end, you might be in a position to redeem at a realized loss since you needed the funds after a year.
Therefore, there is a dual risk involved:
Hence, it is important to stick with your investment goals and make decisions accordingly.
Behavioral bias is a concept related to human nature.
Let’s look at one such bias – overconfidence.
Some investors are overconfident about their investment decisions. They look at the markets and think that there cannot be a further drop and make investment decisions. However, if the markets drop further, the confidence is shattered. Now, the investor is low on confidence and the market is panicking. What kind of decisions do you think such an investor will make? Erroneous decisions, at best. While confidence is good for investors, overconfidence is a behavioral bias that can lead to potential losses. Being adamant about a stock or the performance of the markets is a classic sign of overconfidence.
Read more: 5 Behavioral Biases Investors Must Avoid
Another common behavioral bias is confirmation bias.
There is an adage that says – ‘The eyes see what the mind perceives’. When you watch the news, unknowingly, you only pay attention to the part that confirms your point of view. Let’s say that someone tells you that the stocks of ABC Ltd. can provide great returns in the next few months. You research a bit and start believing in it too. Even if there is information available that says that the stock is overpriced and might not offer good returns, you tend to overlook it and stick with the articles that confirm your belief. This can lead to an erroneous investment decision.
Hence, always ensure that you challenge your point of view and look for data that supports both sides of the coin. Stay neutral and make a data-backed decision.
Diversification is important to reduce the risks of your investment portfolio. In a normal market, investors purchase different assets to ensure that their exposure to one asset is limited.
When the markets crash and panic sets in, diversification is the last thing on people’s minds. Let’s say that you own a well-diversified portfolio. When the markets crash, you feel that the stock price of ABC Ltd has hit rock bottom. You really like this stock and buy it in large quantities. This shakes the balance of your portfolio.
Even if you are planning on investing during a market crash, keep the portfolio diversification in mind at all times. Invest in different assets. If you are investing in stocks, then diversify across market capitalization, sectors, etc. The idea is to avoid risk concentration. If you over-expose yourself to risks in a particular asset or sector and if that goes down, then the possibility of making huge losses increases.
Remember, markets are inherently volatile. They are sensitive to several social, political, and other macro-economic factors. When markets are crashing, you need to ensure that you don’t make the wrong decisions. Hence, think twice before acting on your decisions and assess them critically. Try to look at both sides of the coin and follow the tips mentioned above. We hope that this article helps you deal with the stock market fear effectively. Stay safe.
Disclaimer: The views expressed in this post are that of the author and not those of Groww